Question

1. In the GDP accounts, we subtract imports from the real volume of our exports of goods and services to other countries. Why?

2. Explain the difference between savings and wealth.

3. In the loanable funds market, what/who are the sources of funds?

4. Economists contend there is a real interest rate that can be derived from the nominal rate. How do they derive it and what does it measure?

Answer 1

1. The definition of GDP goes as the market value of all goods and services produced withing a country in a given period of time. In the GDP accounts, the consumption (itself a function of GDP), investment, government spending and exports are added as they attributes to the goods/services produced in the concerned country, whereas import is subtracted as yet it is consumed in the country, but it isn't produced in the country. It can be understood that GDP account balances the income and expenditure of the country, and as export adds to the income, import lessens the income, and hence the term net exports is included the equation, referring to the excess of real volume of export by the import.

2. Difference between savings and wealth is basically the flow and stock variable. Flow variable is measured in an interval/period of time, and stock is measured in a pile of time. Think it like that, supposing that the savings adds up to wealth, the savings will be measured in a period of time, for example savings in a week, month, year, etc, while wealth will be measured at a point of time, for example wealth was 10 on the third day or 100 at the year end. The relation between them in this manner is that, if someone attempts to measure wealth in a period of time, they are actually measuring the change in wealth, which is the savings itself.

3. The market of loanable funds is where the savers interact with borrowers, lending them money at the real interest rate. The source of funds comes from national savings and capital inflow. National savings is a sum of private savings (household savings) and public savings. The capital inflow is the financial inflow of funds into the counrty, stimulated by higher interest ratres than other countries compensated by the regulation and spot market rates. These are the sources of funds in the loanable funds market, which attrubutes to the supply curve in that market.

4. Mathematically, , where i is the nominal interest rate, r is the real interest rate, and is the inflation or expected inflation. The nominal interest rate measures the credit of interest in aggregate term, and doesn't express the increase in the purchasing power. The purchasing power is inversely proportional to the price level, in the sense that as price of products increase, the same amount of money which could buy more, now buys less than before. Hence, the interest rate might be high, but it might be that it will be totally offsetted by the increase in price level, which means that purchasing power of that money saved is the same as before with no increment, in which case it will be said that the real interest rate was zero, however much higher was the nominal interest rate. Hence, the real interest rate is derived by the decreasing the nominal interest rate by the inflation, and reflects the change in real terms, ie change in the purchasing power of the money invested.